Excerpt: - sabyasachi mukharji, j. 1. in this reference, under section 256(2) of the i.t. act, 1961, as directed by this court, the tribunal has referred the following two questions :' 1. whether, on the facts and circumstances of the case, the tribunal was justified in rejecting the claim of the assessee that rs. 25,38,694, the balance in ' surplus' account represented ' reserve ' for the purpose of the act 2. whether, on the facts and in the circumstances of the case, the tribunal was justified in rejecting the claim (of the assessee), that rs. 25,88,011 the balance in ' surplus' account represented 'reserve ' for the purpose of the act ' 2. the first question relates to the assessment year 1963-64, and the second one relates to the assessment year 1964-65. the assessment years involved, as we.....

Judgment:

Sabyasachi Mukharji, J.

1. In this reference, Under Section 256(2) of the I.T. Act, 1961, as directed by this court, the Tribunal has referred the following two questions :

' 1. Whether, on the facts and circumstances of the case, the Tribunal was justified in rejecting the claim of the assessee that Rs. 25,38,694, the balance in ' surplus' account represented ' reserve ' for the purpose of the Act

2. Whether, on the facts and in the circumstances of the case, the Tribunal was justified in rejecting the claim (of the assessee), that Rs. 25,88,011 the balance in ' surplus' account represented 'reserve ' for the purpose of the Act '

2. The first question relates to the assessment year 1963-64, and the second one relates to the assessment year 1964-65. The assessment years involved, as we have mentioned, were two years, viz., the assessment years 1963-64 and 1964-65, for which the relevant accounting years were ended on December 31, 1962, and December 31, 1963, respectively. It appears that on the first day of the accounting year relevant to the assessment year 1963-64, there was a sum of Rs. 25,38,694 shown as surplus in the balance-sheet of the assessee. It would be relevant to set out the balance-sheet as on December 31, 1962, on the reserve and surplus items, which read as follows:

3. In the directors' report to the shareholders presenting the statement of account for the year ended December 31, 1962, the directors had observed as follows :

' Reserves and surplus.

The development rebate reserve has been increased by a further Rs. 3,00,000 and now totals Rs. 74,50,000.

General reserve has been increased by Rs. 20,00,000. '

4. It may also be mentioned that the net profit available for disposal was Rs. 95,59,317. Out of this, the balance-sheet and the P & L a/c. also indicated that the surplus carried forward was Rs. 25,88,011. The amount of Rs. 25,38,694, as mentioned hereinbefore, represented the surplus after making various provisions and reserves, etc. The ITO did not treat this as reserve in the computation of the capital as, in his opinion, it constituted only a mass of undistributed profits. Being aggrieved by the aforesaid order of the ITO, the assessee went up in appeal before the AAC.The AAC was also of the view that the surplus balance in the P & L a/c. could not be treated as a part of the capital fund of the assessee.

5. There was a further appeal before the Tribunal. The Tribunal, in disposing of the appeal, had observed, after noting the rival contentions, as follows:

'We have considered the submissions placed before us. We have also examined some of the balance-sheets and the P/L a/cs. produced before us. We find that no such specific amount, as claimed, has been transferred to any 'surplus account'. Year after year, the net profit shown by the assessee has been added to the surplus left over in the profit and loss account of the earlier year out of which provisions and transfers to general reserve have been made leaving another surplus to be carried forward to the next year. This clearly shows that there is no such specific ' surplus ' but the amount actually represents a mass of undistributed profits in the profit and loss account. We specifically asked the learned representative of the assessee to produce before us a copy of the company's resolution, if any, to prove that there was a clear indication to show that the amount had been transferred to any specific purpose which failed. This goes to show that nobody with any authority on the relevant date had made or declared that above amount as a reserve. '

6. Similarly, for the assessment year 1964-65, the assessee had claimed that the surplus of Rs. 25,88,011 should be treated as a reserve for working out the capital base of the company under Rule 1 of the Second Schedule to the C. (P.) S.T. Act, 1964. The claim was rejected by the ITO and by the AAC.

7. The assessee, after being unsuccessful before the AAC, went up in appeal before the Tribunal. The Tribunal observed that a similar point had come up for consideration in the assessment year 1963-64 and that the provisions of the Act were analogous to those of the Surtax Act. It may be mentioned that the first year was covered by the S.P.T. Act, 1963, and the second year was covered by the C. (P.) S.T. Act, 1964. It is true that the provisions in those two Acts were more or less similar except that, for the second year, Rule 1 of the Second Schedule in respect of the computation of capital for the purpose of surtax contained an Explanation, which was not there for the first year. The Tribunal, therefore, for the reasons given for the previous year, rejected the assessee's appeal. Thereafter an application was made by the assessee for a reference Under Section 256(1) of the I.T. Act, 1961, which was rejected. Thereupon the assessee came up before this court and, as mentioned hereinbefore, as directed by this court, two questions have been referred, as indicated before.

8. Before we take up the material question involved in this reference, in order to complete the narration of facts we must note that, for the second year, our attention was drawn to the balance-sheet and the P & L a/c. for the year ended December 31, 1963, which was passed some time after March 26, 1964. It appears that the directors in their report presenting the statement of account for the year ended December 31, 1963, had observed as follows:

' Reserves.

The development rebate reserve has been increased by Rs. 10,25,000 and now totals Rs. 84,75,000. The general reserve has been increased by Rs. 1,07,01,488. The directors felt it would be prudent to merge the surplus as at 31st December, 1962, and the small provision previously made in respect of retirement gratuities with the general reserve. This accounts for Rs. 30,88,011. Minor profits on sale of assets were credited direct to general reserve. These amount to Rs. 86,524. The remaining portion of the increase amounting to Rs. 75,26,953 represents the balance of the current year's profits after providing for development rebate reserve and proposed dividends. '

9. The P & L a/c. for the year indicated as follows :

Rs.' V. Net profit available for disposal1,68,86,953VI. Surplus brought forward from previous year 25,88,011Provision for retirement gratuities written back 5,00,000

1,99,74,964 '

10. The appropriation column in the said P & L a/c. indicated as follows :

11. So, the second year involved the question whether the sum of Rs. 25,88,011 should be treated as a reserve for working out the capital base of the company under Rule 1 of the Second Schedule to the C. (P.) S. T. Act, 1964. As we have mentioned before, there was an Explanation to Rule 1 of the Second Schedule to the said Act, which was not there in respect of the previous year, which reads as follows :

' Explanation.--For the removal of doubts it is hereby declared that any amount standing to the credit of any account in the books of a company as on the first day of the previous year relevant to the assessment year which is of the nature of item 5 or item 6 or item 7 under the heading ' RESERVES AND SURPLUS ' or of any item under the heading ' CURRENT LIABILITIES AND PROVISIONS ' in the column relating to ' LIABILITIES ' in the ' FORM OF BALANCE-SHEET' given in Part I of Schedule VI to the Companies Act, 1956 (1 of 1956), shall not be regarded as a reserve for the purposes of computation of the capital of a company under the provisions of this Schedule.'

12. On this aspect, the Tribunal has relied mainly on the ground that the sum represented only a mass of undistributed profit and there was no evidence that anybody had decided to treat this as reserve as such. Our attention was drawn to a decision of the Supreme Court in the case of CIT v. Century Spg. and Mfg. Co. Ltd., : [1953]24ITR499(SC) . There the Supreme Court was considering the profit for the year ended December 13, 1945, and it was found that the profit of the assessee-company, whose accounting year was a calendar year, was a certain sum according to the P & L a/c. After making provisions for depreciation and taxation the balance of Rs. 5,08,637 was carried to the balance-sheet. This sum was not allowed in computing the profits of the assessee for the purposes of income-tax. In February, 1946, the directors recommended that out of that amount a sum of Rs. 49,22,436 should be distributed as dividend and the balance of Rs. 16,211 was to be carried forward to the next year's account. This recommendation was accepted by the shareholders in their meeting of April 3, 1946, and the amount was shortly afterwards distributed as dividend. In computing the capital of the assessee-company on April 1, 1946, under the Business Profits Tax Act, 1947, the assessee claimed that the sum of Rs. 5,08,637 and the profit earned by it during the period January 1, 1946, to April 1, 1946, should be treated as reserves for the purposes of Rule 2(1) of Schedule II to the Business Profits Tax Act, 1947. The High Court held that the sum of Rs. 5,08,637, must be treated as a reserve for the purpose of Rule 2 but the profit made by the assessee during the period January 1, 1946, to April 1, 1946, could not be included in the reserves. On appeal, the Supreme Court held that neither the sum of Rs. 5,08,637 nor the profit earned by the assessee during the period January 1, 1946, to April 1, 1946, constituted reserves within the meaning of Rule 2(1) of Schedule II of the said Act. The Supreme Court noted at p. 503 of the report that the term ' reserve ' had not been defined in the Act and, therefore, resort must be made to the ordinary meaning as understood in the common parlance. The Supreme Court referred to the dictionary meaning given in the Webster's New International Dictionary,2nd Edn. Then at p. 504 of the report the Supreme Court went on to observe that what was the true nature and character of the disputed sum must be determined with reference to the substance of the matter and when this was borne in mind it followed that according to the Supreme Court on the facts of the case on April 1, 1946, the sum of Rs. 5,08,637 could not be called a 'reserve' for nobody possessed of the requisite authority had indicated on that date the manner of its disposal or destination. On the other hand, on February 28, 1946, the directors clearly earmarked it for distribution as dividend and did not choose to make it a reserve. Nor did the company in its meeting on April 3, 1946, decide that it was a reserve. It had remained on the 1st of April as a mass of undistributed profits which were available for distribution and not earmarked as ' reserve '. From the aforesaid fact the Supreme Court was of the view that this could not be treated as reserve. The Supreme Court referred to the relevant provisions of the Companies Act and observed that any sum out of the profits of the company which was to be made a reserve or reserves must be set aside before the directors recommended any dividend. In this case, the directors while recommending dividend took no action to set aside any portion of this sum as a reserve or reserves. Indeed, they had never applied their mind to this aspect of the matter.

13. On behalf of the Revenue our attention was drawn to the decision in the case of CIT v. Standard Vacuum Oil Co. : [1966]59ITR685(SC) . There, the Supreme Court was concerned with the business profits tax in respect of an American company and was concerned with the excess value of assets transferred. There the facts were, of course, entirely different. There the assessee, a non-resident company incorporated in Delaware in U.S.A. with the object of taking over the assets of two other companies, the Socony Vacuum Oil Co. and the Standard Oil Company, New Jersey, in consideration of the transfer of assets valued in their books at $ 97,715,701 and $ 46,767,397, respectively, allotted to each company 49,995 shares of $ 100 each and to Socony Vacuum Oil Co. serial bonds of the value of $ 13,093,000. The remaining ten shares of the share capital of the assessee-company were divided equally between the two companies for cash. The assessee-company entered in its books of account the book value of the assets taken over from the companies and the excess of the net value of the assets transferred over the par value of the stock issued and the serial bonds was entered in an account styled ' Capital paid in surplus '. Later, the serial bonds issued to the Socony Vacuum Oil Co. were redeemed. After some adjustments the ' Capital paid in surplus ' account was reduced to $ 117,501,371 and thereafter stood unchanged at that figure. The net profits earned by the company year after year, subject to certain appropriations, were shown in the balance-sheet under the caption ' Earned surplus '. The balance of ' earned surplus ' was $ 29,657,597 at the end of 1945. It progressively increased thereafter and by the end of 1948, stood at $ 73,766,592. The questions were : (i) whether the ' Capital paid in surplus' was a premium realised from the issue of shares within the meaning of Rule 3 of Schedule II to the Business Profits Tax Act, 1947 (ii) whether the ' Capital paid in surplus' and the ' Earned profits ' were reserves within the meaning of Rule 2(1) of the Schedule It was held that it was not necessary that the reserve admissible in the computation of capital should be one built out of profits. Reserves built up from sources other than profits were also admissible for inclusion in capital under Rule 2(1) of the Business Profits Act, 3947, and that ' Capital paid in surplus ' was also a ' reserve' within the meaning of the said Rule 2. It was further held that the expression ' reserve ' meant something specifically kept apart for future use or for a specification. The Supreme Court was further of the opinion that the accumulated profits of the assessee-company at the end of the year were not carried forward into the account of the next year as they could not be, according to the system of accounting prevalent in the United States. They had to be allocated to some account, and they were allocated to ' earned surplus ' which was intended to designate a fund to be utilised for the purposes of the business of the assessee-company, and the amounts so allocated were used in subsequent years in business. The account in which this amount was carried also retained its identity year after year. Therefore, the 'earned surplus ' could not be regarded as mere unallocated profits but represented ' reserves ' within the meaning of Rule 2. The Supreme Court referred to the decision of the court in the case of Century Spg. and Mfg. Co. : [1953]24ITR499(SC) , and after referring to the observations at p. 695, the Supreme Court also referred to the decision of the Supreme Court in the case of First National City Bank v. CIT, : [1961]42ITR17(SC) and thereafter referred to the observations of Mr. Justice Kapur in the said case where the learned judge had observed as follows (p. 695 of 59 ITR) :

' ' There is a difference between the system of accounting of banking companies in India and the United States...... In India at the end ofan year of account the unallocated profit or loss is carried forward to the account of the next year, and such unallocated amount gets merged in the account of that year. In the system of accounting in the U.S.A. each year's account is self-contained and nothing is carried forward. If after allocating the profits to diverse heads mentioned above any balance remains, it is credited to the ' Undivided profits ' which become part of the capital fund. If in any year as a result of the allocation there is a loss the accumulated ' Undivided profits' of the previous years are drawnupon and if that fund is exhausted the banking company draws upon the surplus. In its very nature the ' Undivided profits' are accumulation of amounts of residue on hand at the end of year of successive periods of accounting and these amounts are by the prevailing accounting practice and the Treasury directions regarded as a part of the capital fund of the banking company. '

14. At p. 698 of the report the Supreme Court reproduced the table from the balance-sheet and went on to observe at p. 699 as follows :

' The table disclosed that the balance of 'earned surplus ' at the end of the year did not merge into the account of the subsequent year. It represented a specific account into which were added the net profits of the year and appropriations were made out of it and the balance was regarded as 'earned surplus' at the end of the year. This account was specifically allocated for utilisation for the purpose of business year after year. It was an account in which the net profits less the appropriations were added, and the account was intended for application in extending the business of the assessee-company. The amounts entered in the account, 'earned surplus' cannot therefore, be regarded as mere unallocated profits at the end of the accounting year.

The High Court was therefore right in holding that the ' earned surplus ' represented reserves. The method in which the accounts are maintained in the light of the accountancy practice clearly indicates that, at the end of each year, there have been specific appropriations in the account, and the conditions which this court regarded as essential in Century Spinning & Manufacturing Company's case : [1953]24ITR499(SC) , for constituting the fund into reserve are fulfilled.'

15. Our attention was also drawn to an old decision of this court in the case of Indian Steel and Wire Products Ltd. v. CIT : [1955]27ITR436(Cal) , where Chakravartti C.J., at pp. 442, 443, after referring to the observations of the Supreme Court in the case of CIT v. Century Spg. and Mfg Co. Ltd., : [1953]24ITR499(SC) , observed, inter alia, as follows:

' The only distinction between the case decided by the Supreme Court and the present case is that what their Lordships had to consider, appears to have been simply a sum which was the balance carried to the balance sheet of the next year without making or declaring it a reserve. It was a single sum and was treated as the balance of the year immediately preceding whereas the balance we have to consider in the present case are in each instance composed of two sums, one carried forward or brought over from an earlier year and the other being the balance of the immediately preceding. That distinction, in fact, does not seem to me to make any difference, once it is borne in mind what the test was that the Supreme Court laid down. The crucial date, if I may borrow the language of their Lordships, is thefirst day of the relative chargeable accounting period and the one fact which, in their Lordships' view, furnished the answer to the question they had to consider was that on that crucial date, nobody possessed of the requisite authority had indicated the manner of the disposal or the destination of the balance concerned. The amount of the balance had been simply pushed forward to the next year without being allocated to any particular purpose, whether general or special, and their Lordships held that if a surplus was simply carried forward without the persons in requisite authority allocating it to any particular purpose as a reserve, it did not acquire the character of reserve for the purposes of capital computation under the Business Profits Tax Act. If that be the test, in my view it applies to the whole of the two sums concerned in each of the two instances covered by the present reference. Just as the company had not indicated the manner of the disposal or the destination of the balance of the profits of the year immediately preceding, so it had not indicated the manner of the disposal or the destination of the balance brought over from a still earlier year. The company was merely carrying a loan of unappropriated profits, of which apart was a kind of floating balance which had floated forward into the year immediately preceding and being added to the balance of that year had floated further forward into the chargeable accounting period without finding or being directed to a local habitation in any specific way anywhere at the direction of the company. That being the way in which the two sums had been dealt with, there could not possibly be any distinction between the two for the purposes of capital computation. It follows that in so far as the Tribunal allowed the smaller sums it was in error and in so far as it disallowed the larger sums, it decided rightly. The answer to the first question must, therefore, be in the negative and that to the second question in the affirmative.'

16. Now these cases will have to be reviewed and the question of reserve will have to be decided in the light of the observations of the Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. v. CIT : [1981]132ITR559(SC) . The Supreme Court held therein that the expression ' reserve ' had not been defined in the Act and, therefore, one would be inclined to resort to its ordinary and natural meaning as given in the dictionary. But the Supreme Court felt that the dictionary meaning, though useful in itself, might not be sufficient, for the dictionaries, according to the Supreme Court, did not make any distinction between the two concepts, ' reserve ' and ' provision ', while giving their primary meanings whereas in the context of the relevant legislation a clear distinction between the two was implied. Further, it could not be forgotten that the said words occurred in a taxing statute which was applicable to companies only and to noother assessable entities and as such the expression would have to be understood in their ordinary popular sense, that is to say, the sense or meaning that was attributed to them by men of business, trade and commerce and by persons interested in or dealing with companies. Therefore, the meanings attached to these two words in the provisions of the Companies Act dealing with the preparation of the balance-sheet and profit and loss account would govern their construction for the purpose of the two taxing enactments. The Supreme Court was further of the view that on a plain reading of Clause 7(1)(a) and (b) and Clause 7(2) of Pt. III of Schedule VI of the Companies Act it would clearly appear that though the term ' provision ' was defined positively by specifying what it meant, the definition of ' reserve ' was negative in form and not exhaustive in the sense that it only specified certain amounts which were not to be included in the term 'reserve'. In other words, the effect of reading the two definitions together was that if any retention or appropriation was not a provision, it was automatically a reserve. The question would have to be decided having regard to the true nature and character of the sum so retained or appropriated depending on several factors including the intention with which and the purpose for which such retention or appropriation had been made, because the substance of the matter was to be regarded and in this context the primary dictionary meaning of the term ' reserve ' might be availed of. Therefore, the Supreme Court, it appears to us, tried to make a synthesis of the meaning of the expression ' reserve ' to bring it in harmony both with the dictionary meaning as well as in the context of the provisions of the Companies Act. Therefore, it follows that whether a particular sum is a provision or not should be first adjudged in the light of the provisions of the Companies Act but if it was not a provision then ordinary common sense view having regard to the substance of the matter, and the intention of the company deduced from the circumstances of the situation, should be resorted to. In this connection, reference may be made to the observations of the Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. v. CIT, : [1981]132ITR559(SC) , where the Supreme Court in pp. 568-569 observed as follows :

' The expression 'reserve' has not been defined in the Act and, therefore, one would be inclined to resort to its ordinary natural meaning as given in the dictionary but it seems to us that the dictionary meaning, though useful in itself, may not be sufficient, for, the dictionaries do not make any distinction between the two concepts ' reserve ' and ' provision ' while giving their primary meanings whereas in the context of the legislation with which we are concerned in the case, a clear distinction between the two is implied. According to the Dictionaries (both Oxford and Webster) the applicable primary meaning of the word ' reserve ' is 'to keep forfuture use or employment, to set apart for some purpose or end in view ; to keep in store for future or special use to keep in ' reserve', while ' provision ', according to Webster means : ' something provided for future '. In other words, according to the dictionary meaning, both the words are more or less synonymous and connote the same idea. Since the rules for computation of capital contained in the Second Schedule to the Act proceed on the basis of the formula of capital plus reserves--a formula well-known in commercial accountancy, it becomes essential to know the exact connotation of the two concepts ' reserve ' and ' provision ' and the distinction between the two as known in commercial accountancy. Besides, though the expression ' reserve ' is not defined in the Act, it cannot be forgotten that it occurs in a taxing statute which is applicable to companies only and to no other assessable entities and as such the expression will have to be understood in its ordinary popular sense, that is to say, the sense or meaning that is attributed to it by men of business, trade and commerce and by persons interested in or dealing with companies. Therefore, the meanings attached to these two words in the provisions of the Companies Act, 1956, dealing with preparation of balance-sheet and profit and loss account would govern their construction for the purposes of the two taxing enactments. We might mention here that in CIT v. Century Spg. and Mfg. Co. Ltd., : [1953]24ITR499(SC) , this court, after referring to the dictionary meaning of the expression ' reserve ', observed : ' what is the true nature and character of the disputed sum (sum allegedly set apart), must be determined with reference to the substance of the matter ' and went on to determine the true nature and character of the disputed sum by relying upon the provisions of the Indian Companies Act, 1913, the form and the contents of the balance-sheet required to be drawn up and regulation 99 in Table A of the First Schedule.

The distinction between the two concepts of ' reserve ' and ' provision ' is fairly well known in commercial accountancy and the same has been explained by this court in Metal Box Co. of India Ltd. v. Their Workmen, : (1969)ILLJ785SC thus :

' The distinction between a provision and a reserve is in commercial accountancy fairly well known. Provisions made against anticipated losses and contingencies are charges against profits and, therefore, to be taken into account against gross receipts in the P & L account and the balance-sheet. On the other hand, reserves are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business. Provisions are usually shown in the balance sheet by way of deductions from the assets in respect of which they are made, whereas general reserves and reserve funds are shown aspart of the proprietor's interest. (See Spicer and Pegler's Book-keeping and Accounts, 15th Edn., p. 42. In other words the broad distinction between the two is that whereas a provision is a charge against the profits to be taken into account against gross receipts in the profit and loss account, a reserve is an appropriation of profits, the asset or assets by which it is represented being retained to form part of the capital employed in the business. Bearing in mind the aforesaid broad distinction we will briefly indicate how the two concepts are defined and dealt with by the Companies Act, 1956.'

17. Then the Supreme Court referred to the provisions of the Companies Act and observed at pp. 570 and 571 of the said report as follows :

' On a plain reading of Clause 7(1)(a) and (b) and Clause 7(2) above it will appear clear that though the term 'provision' is defined positively by specifying what it means, the definition of ' reserve ' is negative in form and not exhaustive in the sense that it only specifies certain amounts which are not to be included in the term ' reserve '. In other words the effect of reading the two definitions together is that if any retention or appropriation of a sum falls within the definition of ' provision ' it can never be a reserve but it does not follow that if the retention or appropriation is not a provision it is automatically a reserve and the question will have to be decided having regard to the true nature and character of the sum so retained or appropriated depending on several factors including the intention with which and the purpose for which such retention or appropriation has been made because the substance of the matter is to be regarded and in this context the primary dictionary meaning of the term ' reserve ' may have to be availed of. But it is clear beyond doubt that if any retention or appropriation of a sum is not a provision, that is to say, if it is not designated to meet depreciation, renewals or diminution in value of assets or any known liability the same is not necessarily a reserve. We are emphasising this aspect of the matter because during the hearing almost all counsel for the assessees strenuously contended before us that once it was shown or became clear that the retention or appropriation of a sum out of profits and surpluses was for an unknown liability or for a liability which did not exist on the relevant date it must be regarded as a reserve. The fallacy underlying the contention becomes apparent if the negative and non-exhaustive aspects of the definition of 'reserve' are borne in mind. Having regard to type of definitions of the two concepts which are to be found in Clause 7 of Part III, the proper approach in our view would be first to ascertain whether the particular retention or appropriation of a sum falls within the expression ' provision ' and if it does then clearly the concerned sum will have to be excluded from the computation of capital, but in case the retention or appropriation of the sum isnot a provision as defined, the question will have to be decided by reference to the true nature and character of the sum so retained or appropriated having regard to several factors as mentioned above and if the concerned sum is in fact a reserve then it will be taken into account for the computation of capital.'

18. The Supreme Court also referred to the decision in the case of Century Spg. and Mfg. Co., : [1953]24ITR499(SC) , as also the decision in the case of First National City Bank Ltd. v. CIT, : [1961]42ITR17(SC) and the CIT v. Standard Vacuum Oil Co. Ltd., : [1966]59ITR685(SC) , the two decisions which we have referred to hereinbefore, and the Supreme Court, referring to the observations mentioned hereinbefore, observed at p. 582 of the said report, in respect of these two cases, as follows :

' This court in the first case held that the amount designated as ' undivided profits ' which was available for continuous future use of the business of the bank was a part of the reserve and had to be taken into account while computing the capital under Rule 2(1) of Schedule II to the Business Profits Tax Act; similarly, in the second case the court held that the amount which had been allocated to ' earned surplus' which was intended for the purpose of the business of the assessee-company and was used in subsequent years in business, represented ' reserves ' within the meaning of Rule 2 of Schedule II of the Business Profits Tax Act, 1947. From these two decisions two aspects emerge very clearly. In the first place, the nomenclature accorded to any particular fund which is set apart from out of the profits would not be material or decisive of the matter and, secondly, having regard to the purpose of Rule 2 of Schedule II of the Business Profits Tax Act, 1947, if any amount set apart from out of the profits is going to make up the capital fund of the assessee and would be available to the assessee for its business purposes, it would become a reserve liable to be included in the capital computation of the assessee under that Act.'

19. The Supreme Court noted thereafter that since they had reached the aforesaid conclusion on the first principles and on the basis of the guidelines discussed above, the Supreme Court felt it unnecessary for them to go on to discuss the scope or effect of the Explanation to Rule 1 in the Second Schedule to the 1964 Act, though the Supreme Court felt that, prima facie, that Explanation was declaratory of the existing legal position.

20. Bearing the aforesaid principles in mind, so far as the first year is concerned, viz., January 1, 1962, in the balance-sheet it appeared that the directors observed the general reserve increased by Rs. 20 lakhs and the directors had treated this amount of Rs. 25,88,011 as surplus after making specific provisions for other contingencies and also provisions for dividend and other matters. It appears to us that this sum could not be treated as provision. Though it was a mass of undistributed profits the directorshad decided not to earmark it for any specific contingency or purpose. Therefore, having regard to the substance of the matter and following the principles of the Supreme Court in the last-mentioned case, on the facts of this case, it should be held that the sum represented a reserve in terms of the relevant Rule 1 in the Second Schedule.

21. So far as the next year is concerned, some dispute was there as to whether the balance-sheet for the year ending March 31, 1963, would be relevant or not. We find, though the Tribunal has not annexed the balance-sheet, the Tribunal had noted in its order that they had also examined some of the balance-sheets and P& L a/c. produced before them. Now in the balance-sheet if the question involved for the second year is considered on the first principle as enunciated by the Supreme Court then the Explanation would not really make any difference. But in this year it has been specifically decided by the directors to merge the surplus as on December 31, 1962. We have referred to it. Learned advocate for the Revenue sought to urge that this balance-sheet would be effective only from April 1, 1964. Firstly, it appears from the expression used, the directors noted, that the general reserve had been increased by Rs. 1,07,00,488 and the directors felt that it would not be prudent to merge the surplus as on December 31, 1962. Therefore, the merging of surplus as on December 31, 1962, could take effect only from January 1, 1963. That account naturally must be passed in the year when the accounts and the balance-sheet for that year would be passed, i.e., after the close of the accounting year. In this connection, it would be relevant to bear in mind that when accounts have been closed and approved by the shareholders, the directors could make any recommendation for the profits from the shares. But when the accounts have not yet been closed and passed, the directors could not make any appropriation of the profits from the particular date and such appropriation will take effect from that date on which the accounts are passed. Therefore, the directors stated that in the accounts for the year ending December 31, 1962, they decided to merge the surplus standing on December 31, 1962, as general surplus which must be effective from January 1, 1963.

22. Though not actually on similar facts, the same principle, in our opinion, follows from the observations of the Supreme Court in the case of CIT v. Mysore Electrical Industries Ltd., : [1971]80ITR566(SC) . But as mentioned above, the facts are slightly different and, in this connection, reference may be made to the observations of the court at p. 569 of the report, which read as follows :

' It is well known that the accounts of the company have to be made up for a year up to a particular day. In this case that day was the 31st March, 1963. If it was reasonably practicable to make up to theaccount up to the 31st March, 1963, and present the same to the directors of the respondent on April 1, 1963, they could have made up their minds on that day and declared their intention of appropriating the said and other sums to reserves of different kinds. But the fact that they could not do so for the simple reason that the calculation and collection of figures of all the items of income and expenditure of the company for the year ending March 31, 1963, was bound to take some time cannot make any difference to the nature or quality of the appropriation of the profits to reserves as determined by the directors after the first of April, 1963. Their determinatition to appropriate the sums mentioned to the three separate classes of reserves on the 8th August, 1963, must be related to the 1st of April, 1963, i, e., the beginning of the accounts, for the new year and must be treated as effective from that day.'

23. This view finds corroboration in the observations of the Bombay High Court in the case of Parke Davis (India) Ltd. v. CIT : [1981]130ITR813(Bom) , where the court dealt with this question at pp. 816-818 though this point we have mentioned was conceded by all parties concerned. Similar view was taken by the Punjab Haryana High Court in the case of CIT v. Oswal Woollen Mills Ltd. .

24. Our attention was, however, drawn to certain observations of the Punjab & Haryana High Court in the case of Oswal Cotton Spinning and Weaving Mills Ltd. v. CIT, . But that was in the context of different controversy and, therefore, it is not material to refer to the said decision in detail.

25. For the reasons aforesaid, in our opinion, the Tribunal was in error in respect of both these years and, therefore, both the questions must be answered in the negative and in favour of the assessee.

26. In the facts and circumstances of this case, however, parties will pay and bear their own costs.